JotCast | Energy & Income Advisor Live Chat December 2020

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Energy & Income Advisor Live Chat December 2020

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Roger Conrad

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Hello everyone and thanks so much for joining us with our final Energy and Income Advisor live chat for 2020.

There is no audio. Type in your questions and we’ll get to them as soon as we can concisely and comprehensively. As always, we’ll send you a complete transcript of all the Q&A shortly after we sign off, which will be when there are no more questions left in the queue or from emails we received prior to the chat.

As usual, we’ll start with answers to those queries.

Q. Gentlemen. Been a good little soldier...Energy and Income Advisor/Conrad’s Utility Investor portfolios duly executed. My question is do you recommend 10 percent of the portfolios’ value to be in physical gold for insurance?

I have been doing this. But at age 66, I am beginning to wonder what’s the point? The gold has not given me one dime of enjoyment, rather only storage fees. Selling incurs taxes approaching 40 percent in my state. Wouldn’t oil protect as well if inflation really takes off? If I had bought NextEra Energy (NYSE: NEE), I would have been way ahead. Do you folks insure with gold, and if so, how much?—David O

A. David, we’re pretty bullish on gold going forward. The metal’s price appears to have consolidated its gains from earlier in the year and has been trending higher this month. As Elliott has often discussed, one primary driver of higher prices is very low “real” interest rates, basically nominal rates less inflation. That’s a conscious choice right now for monetary policies around the world as fallout from the pandemic continues to depress global growth. And while inflation right now is pretty flat, prolonged periods of very low real rates have historically revived it.

We think gold prices are headed much higher from here, at some point making an assault on $3,000 an ounce which, would definitely make anyone’s current holdings much more profitable. But that said, there are many ways to get exposure to stronger gold prices than holding physical bullion.

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One alternative we’ve recommended in the past is the SPDR Gold Shares ETF (NYSE: GLD), which has some expenses but otherwise tracks gold’s price pretty well. Gold focused stocks like Newmont Corp (NYSE: NEM) are another way to bet on the metal—you get more upside leverage to price moves with stocks and Newmont actually pays a yield of a little less than 3 percent to hold it.

Oil has historically been a driver of inflation as well and we’re bullish on energy prices for 2021. But it’s arguably no longer as good a play on inflation as it was in the 1970s, mainly because the US is now a net exporter of energy and the US dollar is no longer weakened by big capital outflows for imports.

The bottom line is we like gold as an investment—but the right way to own it is going to vary with the investor.

Q. Gents: You previously identified China Unicom (Hong Kong: 762, NYSE: CHU) and China Telecom (Hong Kong: 728, NYSE: CHA) in a prior issue. Can you tell me if you recommend these Chinese telephone companies CHU and CHA for purchase? If so, what are their buy limits?
Are they “aggressive” or “conservative” purchases? Thank you.—Barry J.

A. Barry, we do track China Unicom and China Mobile (Hong Kong: 941, NYSE: CHL) in the Conrad’s Utility Investor coverage universe, and have considered picking up China Telecom as well. I like the business fundamentals of these companies over the next several years.

For one thing, I believe they’ve really benefitted from the global shunning of Chinese equipment maker Huawei, which has forced that company to concentrate on its home market when it comes to rolling out 5G networks. And China’s isolation also seems to have caused the government to shift from what was shaping up as a more confrontational stance on regulation to a much more supportive role.

The result is these companies have been able to deploy 5G far more quickly and cheaply than expected. For example, China Mobile has gone from close to zero 5G customers at the start of 2020 to nearly 150 million as of the end of November. That compares to an initial end-year goal of 100 million. And not only are Chinese adopting 5G but they’re paying more for it, demonstrated by 5 to 6 percent higher average revenue per user at the company.

Those favorable trends are already starting to have a favorable impact on Chinese telecoms’ revenue and earnings. The reason it hasn’t so far on these companies’ share prices is the Trump Administration’s decision to ban US investors from owning them. Mainly, unless reversed by the incoming Biden Administration, these stocks will be removed from global benchmark indexes and delisted from US exchanges in 2021.

China’s Big 3 telecoms have little debt, are state supported and generate massive amounts of free cash flow. So forcing their stocks off exchanges and barring US investors from owning them won’t affect their ability to grow 5G networks one iota. But this policy would make life very difficult for any US investor who wants to own these stocks.

I honestly can’t recall any time in my 35 plus years in this business when the US government actually barred Americans from owning publicly traded companies from any country. It’s a policy change that’s apparently opposed by the current US Treasury Secretary on the grounds that it would hurt only US citizens. But because I can’t tell you with assurance it will be rolled back next year, I think these stocks are best avoided for the time being.

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Q. Hi. Since it's more expensive to heat homes with electricity versus oil or natural gas, I don't understand why experts say it is cheaper to run cars on electricity. Are they correct, and could you explain?

Also, since politicians are determined to rid cars of using petroleum, could you name in descending order the midstream pipeline companies that will most benefit from using natural gas, which will be needed to supply electricity.

After we see a recovery in oil prices this year, my thoughts are that I should slowly wind down my position in midstream pipeline companies that are more heavily dependent on oil vs. natural gas. Which pipeline companies are most vulnerable in this transition to electricity? Thanks—Jack A.

A. Hi Jack. Thanks for that very interesting question. It’s fair to say we’re highly skeptical batteries will replace internal combustion as the primary means of propulsion anytime soon—regardless of how much politicians want to please their voters. Thanks in large measure to Chinese mass production, the cost of batteries has certainly come down a long a way the past 10 years. Efficiency and longevity have greatly improved as well. And with all the money now going into research and development—as well as to scale and automate manufacturing—there’s no reason those favorable trends can’t continue.

But despite the progress made, battery-powered cars are still at a substantial disadvantage on key issues such as cost, range, speed of refueling, safety and vehicle weight. And while generous tax credits may increase adoption rates in the US and elsewhere the next few years, any negative impact on gasoline demand will almost certainly be dwarfed by the effect of a return to more normal consumption patterns from

driving as well as plane travel.

Let’s assume there are breakthroughs that make EVs a lot more competitive by 2030, and don’t simultaneously trigger a shortage of the world’s supply of resources like nickel that would substantially drive up costs. After all, this is what the world wants right now and there is a lot of money being invested trying to provide competitive EVs. And let’s also say that major countries mandate all gasoline-powered vehicles be immediately replaced with EVs by 2030.

You’re first going to need a huge investment in electricity transmission and distribution infrastructure. The electricity industry will happily provide it, but only so long as they can earn a fair return on the investment. Assuming regulators grant it, you’ll then need to be able to ensure there’s always enough electricity flowing on the grid to provide all of that charging. Again, it’s possible to imagine enough advances in utility scale batteries to provide 24-hours a day storage for intermittent wind and solar

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generation. But as California’s summer 2020 heatwave proved, it doesn’t exist now. And with baseload power stations using nuclear, coal and the like shutting down, there’s only natural gas to fill the breach in times of crisis.

Of course, there’s no shortage of advocates for moving away from natural gas immediately. Berkeley, California has already banned gas infrastructure in new buildings. And some municipalities in Massachusetts, New York, Ohio, Oregon and Washington have enacted similar laws. But with Arizona, Louisiana, Oklahoma and Tennessee passing laws forbidding cities taking such action—and statehouses in at least four other states considering the same—this is by no means a universally held view. And in fact, gas companies are already taking steps to cut emissions with pipe replacement, mixing in “renewable” gas from farms and exploring use of hydrogen that will take off the pressure.

It’s quite possible that means natural gas pipelines are ultimately at less risk to eventual shutdown than oil focused ones. But we don’t think it’s worth making a distinction between midstream companies on that basis.

For one thing, pipelines are frequently repurposed from one fuel to another. In recent years in North America, the direction has been toward higher margin oil and away from lower margin gas. But that could eventually reverse, with midstream companies utilizing their right-of-ways and infrastructure to ship the commodity that offers the highest degree of profitability

The key is always to have the resources and reach to make the move. That’s something large and diversified midstream companies can do, and smaller less diversified ones mostly can’t.

Another complicating factor is that much of the natural gas produced now is “associated gas,” which is basically a byproduct of drilling for oil. Rather than burning it off or “flaring,” producers are now shipping it from shale basins like the Permian via huge pipelines, such as the Permian Highway Pipeline opened this month by Kinder Morgan. If you take away oil, would the gas still be profitable enough to keep flowing through these pipelines

As they’re not primarily transporting associated gas, pipelines coming out of places like Appalachia or the Barnett Shale in Texas would in theory be less exposed to a big drop in associated gas flow. Williams Companies—one of our High Yield Energy List picks—is a major owner of this type of infrastructure.

But the bottom line here is that it’s not the nature of the pipelines but the makeup of the overall midstream companies themselves that separate the good investments from the bad ones. Time and again during the pandemic year, we saw the large, diversified and financially strong players show resilience as businesses—several like Hess Midstream and Kinder raising dividends—even while the rest of the industry was wrecked with record dividend cuts and bankruptcies. And those same strengths will enable the best in class to adapt to whatever energy policies come down the pike, even while the weaker fare slip further.

Q. HAPPY NEW YEAR, FOLKS! And may it be a good one for you and yours. Two questions. First, do you still have your doubts about the dividend of Oneok (NYSE: OKE)? Do you still believe the current high 30s price is too high for entry? Second, how do you feel about Holly Frontier (NYSE: HFC)? I know you are bullish on Valero (NYSE: VLO). Is HFC also a buy at its present price? Many thanks.—Jeffrey H

A. Thanks Jeffrey and the same to you! Starting with ONEOK, the dividend next year and going forward depends heavily on volumes shipped through its system and whether that will produce enough cash flow to meet debt reduction goals. That’s going to be largely determined by what sort of activity we see in the Bakken, where the company has made a very big investment in recent years. The expenditure has been made, CAPEX is set for a big decline next year and there’s plenty of spare capacity to absorb a huge rebound in volume without new investment.

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The uncertainty comes from oil prices that are still south of $50 a barrel at WTI Cushing and about $2 per barrel less than that at the key Bakken hubs. The company relies on associated gas to fill its pipes. And if those prices aren’t high enough to encourage oil drilling, there won’t be gas as we saw in Q2. There’s also the question of producers moving resources from the Bakken to the Permian following recent sector mergers.

ONEOK did see a huge uptick in volumes in Q3 from Q2 levels—and the result was dividend coverage went from a shortfall to a strong surplus. If those trends continue, the company won’t have any problems generating enough free cash flow from operations to cut debt in line with targets—and maintaining the current dividend rate. If there’s a continuing volume shortfall, I think management will consider a dividend cut by the middle of 2021. That’s why the company is on the Endangered Dividends List. It’s a buy up to 40 for aggressive investors because I think the yield of nearly 10 percent

more than compensates for the risk—and if they do continue show resilience this is at least a $60 stock by mid-2021.

We continue to be bullish Valero and cautious on Holly Frontier, mainly because location of facilities differs so widely. Basically, Valero is ideally situated to play a volumes recovery while HFC is still vulnerable financially to a continued slump.

Q. Roger and Elliott: The Wall St. Journal on Monday had a front-page article that talked about the implications of long-term declines in global oil demand. Do you agree with the assumption? Does that suggest that oil producers and pipeline companies are not suitable long-term holdings?

There is a lot of talk about big pension funds divesting energy stocks and banks no longer lending to energy companies. Is this just talk, or is this something that long-term energy investors need to worry about?

Thanks as always for your excellent work. You stand out in the Value for Price Category! Happy New Year.—Ken V.

A. Thank you Ken. The conventional wisdom is certainly that we’ve already passed peak demand for oil. As I answered to Jack’s question above, EVs may some day advance far enough to replace gasoline powered cars, and certainly there’s a great deal of money being invested that end as well as political support for it. But we’re extremely skeptical about the ability of EVs to replace gasoline powered cars in the next decade—let alone before demand recovers from this past pandemic-affected year, which is really the basis for our bullishness on the sector. Our view is the past year’s huge pullback in industry investment has accelerated the energy price cycle to the extent that supplies will be constrained much faster than they would have otherwise been. And the combined with recovering demand will produce quite robust gains for energy prices—and particularly for energy stocks. The inflection point for a shift in investor psychology to a more positive footing is, we believe, a move to the mid-50s in oil prices that

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holds. And we expect that to catalyze substantial returns in our EIA Model Portfolio stocks.

Headlines in popular publications proclaiming the death of industries are common at major turning points in the cycle. And we think that will prove the case this time. As for divesting from energy stocks, this is not a new development. In fact, energy as a sector is now at an historically low percentage of portfolios, and particularly relative to their portion of the real economy. The impact of that pullout is in other words done. All that can really happen now is for energy’s share of these portfolios to increase

PHILIP B.

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Dear Roger & Elliott,

Please give us your comments on PSX Phillips 66. I already own the stock and am wondering whether I should hold and continue to collect the 5% dividend or move the money elsewhere?
Thanks for your many years of profitable advice

Elliott Gue